The Futures / Inter Market Report

Trading the World’s Markets                            

May 25, 2007

                                            
Matthew Caruso, CMT                                  
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A Study of Current Market Sentiment

When trading the market it is very easy to be affected by your emotions. This is not a problem faced only by new participants of the markets, but also a problem that advisors face as well. There are a number of polls that monitor the percentage of advisors that are bullish or bearish on a certain investment vehicle in order to trade contrary to their opinion when they reach extreme levels of optimism and pessimism. One of these sentiment tools is offered by Genesis Financial Technologies and is called the Larry Williams Sentiment Indicator.

Sentiment indicators can be a valuable tool to any investor for a number of reasons. One important reason is that they are not based on price and therefore they are giving investors a view of the market level that is independent to any price base indicators such as the RSI indicator, moving averages, or support and resistance areas. Although they are useful and fairly accurate, they must be used in direction of trend. This does not mean however that excessively bullish sentiment readings are not useful in an uptrend. They are useful in giving investors an idea of when to take profits or not initiate new long positions. Trading against the trend is not a wise decision and therefore bearish readings should be used to enter long in uptrend and bullish readings in uptrends should be used only to take profits or avoid new longs, vice versa for downtrends.

This week a number of markets are at emotional extremes. The Japanese Yen, Swiss Franc, Gold, Platinum, 5 year bond, 10 year bond, and 30 year bond futures are all at bearish emotional extremes with only 25% or less of advisors being bullish on these markets. The Coffee, Lumber, Soybean oil, Soybeans, Soybean Meal, and Cotton futures are at bullish emotional extremes with 75% or more of advisors in these markets being bullish. What level is considered extreme? When only 25% (preferably less than 15%) or less of advisors are bullish, I consider the market to be at a bearish extreme. When 75% (preferably 85%) or more of advisors are bullish, I consider that a bullish extreme.

What I find to be especially important about these current extreme readings is that they are occurring in related markets. When related markets give similar indications, there is a higher probability for a market to react than when a single market does. This week Soybeans, Soybean Oil, and Soybean Meal are all at a bullish emotion extreme as can be seen in figures 1, 2 and 3. The red arrows in figures 1, 2 and 3 show that when sentiment reaches a bullish extreme the markets tend to reverse down or pause sideways.

The Japanese Yen, Swiss Franc, and 10 yr Bond are all related. Foreign exchange rates are affected by U.S. interest rates and therefore move somewhat in tandem. All of these markets have only 25% or less of advisors bullish this past week as can be seen in Figures 4, 5, and 6. Previous occurrences of excessively bearish sentiment have led to trend reversals or pauses in trend.

Figures 1 to 6 clearly demonstrate that the consensus of advisors is typically wrong when it reaches an extreme. The most important market maxim is that the trend is your friend but theses examples of sentiment show that it is important that you select the right time to enter it. Even if the trend is up, entering long when most advisors are bullish is not a wise thing to do.


Figure 1


Figure 2


Figure 3


Figure 4


Figure 5


Figure 6